The Year-End Tax Move That Turns Capital Losses in a Brokerage Account Into Tax-Free Roth Dollars

You sold a losing position in March, locked in a real loss, and now you’re sitting on a taxable account with a gap where that investment used to be. Pairing that loss with a Roth conversion before December 31 can let the IRS help fund tax-free growth.

You can take a $50,000 capital loss, move it to a Roth through a Roth conversion, and shield it from income tax almost entirely. Get it wrong, and you trigger the wash sale rule and lose the loss permanently.

Why Capital Losses and Roth Conversions Work Together

A Roth conversion adds ordinary income to your tax return. A realized capital loss reduces your taxable capital gains first, then offsets up to $3,000 of ordinary income per year with any remainder carried forward indefinitely. When you harvest a loss in your taxable account and simultaneously convert pre-tax 401(k) dollars to a Roth, the conversion income fills the space the loss created.

Then, the money grows in your Roth IRA without incurring additional taxes. You can then withdraw from this account deep into retirement without having to worry about how tapping into your capital will affect your tax rates.

The Wash Sale Rule That Destroys the Strategy

After selling a losing position to harvest the loss, many immediately repurchase the same fund inside their Roth IRA. That triggers the wash sale rule. The IRS treats a purchase of a substantially identical security in any account, including an IRA, within 30 days before or after the taxable sale as a wash sale, and the loss is permanently disallowed.

The fix is straightforward. Sell the losing position in the taxable account. Wait 31 days before buying it back, or immediately buy a similar but not substantially identical fund to maintain market exposure. For example, if you sold an S&P 500 index fund at a loss, you could immediately buy a total market fund or a large-cap value ETF to stay invested. After 31 days, you can return to your original holding. The loss is preserved, and the Roth conversion proceeds as planned.

What the Numbers Look Like in Practice

Take a 62-year-old single filer with a $1.2 million traditional 401(k), $90,000 in pension and Social Security income, and $40,000 in realized capital losses from market volatility. Her baseline MAGI is $90,000, well below the $109,000 single-filer threshold ($218,000 for married couples filing jointly) before high-income Medicare Part B and Part D surcharges take effect. She has room to convert roughly $19,000 before hitting the cliff.

With $40,000 in capital losses, she first offsets any capital gains. If she has $15,000 in gains, the losses reduce her net capital income to zero and she carries $25,000 forward. Her MAGI stays at $90,000. She can now convert up to $19,000 and remain under the threshold. The conversion grows tax-free inside the Roth. Future withdrawals don’t count as MAGI, which means they won’t trigger Social Security taxation or Medicare surcharges in later years.

For income inside the Roth, Schwab U.S. Dividend Equity ETF (NYSE:SCHD | SCHD Price Prediction) yields roughly 3.4%, and JPMorgan Equity Premium Income ETF (NYSE:JEPI) yields around 8.5%. Inside a Roth, those distributions compound without any tax drag.